US chip leadership is in trouble - but business is good

I meet with top representatives of the US chip industry every year for an update on their markets and the trends that shape their future. This time around, George Scalise, the head of the Semiconductor Industry Association (SIA) and top communications execs from Intel, Texas Instruments, IBM and others, provided an interesting meeting and described a good news/bad news type of scenario.

The good news Mr Scalise said is that the chip industry is doing well, forecasts have been raised for this year and the SIA is expecting revenues of about $250bn. And in all chip markets demand is good and growing at a steady rate. "There is nothing that we can see that is a problem, even the high fuel prices haven't hurt consumer demand."

Consumer markets now account for more than 50 percent of global chip revenues, so consumer spending and sentiment is closely watched by the SIA. And since consumer spending accounts for more than 60 per cent of the overall economy, there is room for chip revenues to continue to climb just on the dynamics of that sector alone.

Inventories of chips are low, and utilization levels of the chip fabs are very good, about 92 per cent, which means there is room to expand without causing shortages but high enough that price pressure remains low.

The bad news is that US is likely to lose its lead in chip manufacturing expertise and that could be catastrophic to the US economy. The SIA and the chipmakers and other groups are lobbying hard in Washington D.C. to make sure that the US funds more basic research, invests in education so it has a highly skilled workforce, and can provide new ways to finance multi-billion dollar fabs.

"There is no other industry like the chip industry that has created so many jobs, and has contributed so much to the GDP of this country," said Mr Scalise. So far so good, I said. Why should we be so concerned about the future when the US chip industry is doing so well?

Mr Scalise and the others, pointed out that it is becoming more difficult to manufacture in the US because of fewer science and math students, and the economic incentives are much less than those offered in other countries. Yet each chip fab provides significant economic value to the host country because of the infrastructure that grows around it. Many other countries recognize that benefit and are offering significant incentives for chipmakers.

One worrying trend is China. Mr Scalise and his team recently returned from a fact finding trip to China. He said that SMIC, the country's largest chip maker, is able to take advantage of sweetheart financing deals. The government of a large province in China is building billion dollar fabs and it will lease them to SMIC. This means SMIC doesn't have to raise billions in capital markets to finance its expansion. This is a significant competitive advantage for SMIC.

I asked if this is a World Trade Organization issue, but subsidies of various kinds are allowed. The US chip industry enjoys subsidies on a smaller scale from US regional governments, tax holidays, etc.

How will US state governments compete against deals of the SMIC-type? I can't imagine Arizona or New York state governments raising money to build billion dollar fabs and leasing them out. "Well, we can be creative in other ways, and we'll have to be," says Mr Scalise.

China is also training masses of engineers, narrowing the skills gap with the US. The SIA wants the government to make it easier for foreign-born student engineers to obtain green cards so that they can stay here in the US instead of returning home after completing their studies.

The problem is to convince US politicians to make the legislative changes that improve education, fund more basic research, and provide for ways of accessing cheaper capital. Dan Larson, director of government and media relations for Texas Instruments said, "We have had a good response to our message but getting the legislation passed is a long process and can be derailed by other factors."

I was glad to hear that the SIA and the chipmakers are doing a lot to try and raise educational standards in their communities. Its one thing to lobby in Washington, but it's another to work locally and walk the talk. The chip industry spends nearly a quarter of a billion dollars a year on educational ventures. Texas Instruments and IBM for example, encourage their engineers to get involved in local schools and colleges.

But it is a tough situation for the chip industry to say the sky is falling when its business is pretty good, and getting better.